Mongolian investors hope good times will roll again

By bne IntelliNews March 20, 2014

Terrence Edwards in Ulaanbaatar -

Mongolia doesn't attract the same amount of foreign investment as it used to and many investors have cut their losses and left. But some high-profile executives are standing their ground with the expectation that the good old days will return soon.

"There's a lot of money that needs to come into Mongolia, and it's not going to come in by itself," says Cameron McRae, who took on the role of executive chairman to Ulaanbaatar-based investment and advisory firm SkyPath Partners after nearly three years as the country manager for Rio Tinto in Mongolia, where he headed the giant $6.5bn Oyu Tolgoi copper-gold mine in Mongolia's Gobi desert.

McRae says he decided to stay on in Mongolia after stepping away from Oyu Tolgoi and Rio Tinto last November to see the country's fledgling mining industry meet its potential. He also expects the emergence of new industries in Mongolia to contribute to the nation's growth.

But the money coming in today is far less than in 2011, when economic growth peaked at 17.5%. Mongolia saw a 36% decline in foreign direct investment at the end of January from the year before. This has impacted on the economy; the Mongolian currency, the tugrik, depreciated 19% last year, which is partly responsible for a rise in inflation to 12.3% because the country is so heavily dependent on imported fuel and food. Growth fell to 11.8% in 2013, but the 9.8% growth projected by the International Monetary Fund for this year puts the country among the highest growing economies in the world.

McRae has spent much of his career in Mongolia as a peacemaker managing the fraught relations between the government and Rio Tinto over Oyu Tolgoi, but his past struggles have not deterred him. Rio owns 66% of the mine indirectly through its majority owned subsidiary Turquoise Hill Resources, while the government owns the remaining 34%. Under McRae's watch, in August last year Oyu Tolgoi suspended the next stage of the mine's development - where it says most of the deposit wealth will comes from - because of disputes with Mongolia's government, mainly concerning development costs. Given Oyu Tolgoi's importance to the wider economy, hiccups in this project have tended to have big knock-on effects on investor confidence and the wider economy.

But Mongolia is now trying to make amends with investors. In November it enacted its new Investment Law, which removed the legislative hurdles put in place in mid-2012 that most agree were the reason that investment started fleeing Mongolia. The country at the start of this year also introduced laws that create a better regulatory system for the country's capital market and better environment for institutional investors in which to operate.

However, what may be keeping investors at bay are the continuing disputes the government has with Rio Tinto and other mining outfits. Another unresolved issue is the 106 licenses that Mongolian courts ordered cancelled because of criminal charges against the officials that had approved them.

McRae is advising Kincora Copper, which had to explain to investors a C$7m write-down because of the cancelled licenses. He thinks the Mongolian government understands investors' gripes, however, and it is doing its best to build the kind of environment required to flourish. "I say often it's not about having good philosophy for your laws, they've got to be competitive to other jurisdictions and also want to get that same money streaming into their country, and I think the government is coming to grips with the need to have that competitive environment."

Real estate bull

McRae is not alone in his optimism about Mongolia. Property development veteran Paul Byrne is CEO of the commercial real estate-focused Mongolia Growth Group. His resume boasts eight years leading commercial real estate development activities for the $3.2bn Hong Kong International Airport and client representative to the New York Port Authority for reconstruction of the World Trade Center.

While the $80m that Byrne says Mongolia Growth invested pales in comparison to the multi-billion-dollar projects and company portfolios he's worked with in the past, he sees more growth potential in shear scale here. The western market "doesn't see step changes like emerging markets," says Byrne.

Byrne is tasked with taking his company from one focused on second-tier commercial space to the country's "preferred real estate company and the dominant one." Up until now, Mongolia Growth has focused mostly on renovations and providing western-standard office and retail space in a city where most construction projects forego international standards for design and safety. The next step, says Byrne, will be the development of entirely new properties while maintaining the same strategy employed in their renovated properties. "Our point of difference would be to build better standard buildings going forward, run them better, and managing them better."

The country's frothy real estate markets have suffered since the global economic crisis. The office market began to recover began in 2010, however, and a 2014 report by another Ulaanbaatar-based properties firm, Asia Pacific Investment Partners, showed an approximate 14% rise in office rental prices to about $24.50 per square meter for top-tier space. Unfortunately, a lot of newly built office supply coming onto the market won't help demand.

But Oyu Tolgoi could be a game changer. The signing of an investment agreement for Oyu Tolgoi was largely responsible for the resurgence of economic growth in 2010, and analysts anticipate a similar scenario if the current issues surrounding Oyu Tolgoi are resolved. "There was a lot of OT [Oyu Tolgoi] money for secondary circulation that was being used to invest in real estate," says McRae. "In one respect you could say part of UB [Ulaanbaatar] has been built on the confidence of the OT project."

Made in Minegolia

Nicknamed Minegolia for its heavy economic dependence on its minerals - copper, coal, iron ore and oil products represent about 77% of exports - Mongolia is utilising new tax stability incentives designed to encourage investment in areas other than resource extraction and in locations throughout the vast country. The government is also teeing up the infrastructure projects for transportation and power that the country sorely needs.

McRae intends to help investors learn how they can participate in the massive reconstruction effort, as well as other basic societal needs missing in the remoter corners of the world's most sparsely populated country. "You've got a huge wealth of infrastructure that needs to be built in the country - whether it's replacing power stations, or extending the grid nationally," he says. "You can talk about schools and hospitals as government responsibility, but the private sector can play a very significant role in building and funding these projects."

Mongolian Prime Minister Norov Altankhuyag is making the transition from an import-oriented nation to one that can produce its own goods for domestic consumption and export a principal focus of his government. The PM has ordered that $230m of a $1.5bn sovereign bond issued in 2012 be used to finance the establishment of at-home industries for downstream processing of the minerals mined here, as well as agriculture, light industry and the production of materials for home and building construction.

Opening up new industries for clean energy generation, oil shale exploitation and coal-to-liquid fuel production are also long-term goals. In March, the Mongolian government announced it was pressing on with a joint venture with China's Sinopec to commission a gasification plant for Mongolia's reserves of lignite, also known as brown coal, by 2018.

And that's just where the country should be headed, says Byrne. Today, Mongolia is still vulnerable to external market influences. For example, the country's National Statistical Office reported an 11.8% decline in coal revenues in February from the year before, which is due at least in part by a 24% price decline at the border for coal products and weakening demand from China. Creating a more complex market that includes the production of diverse goods will mitigate these risks for the future.

"Sometimes what you see in emerging markets is, until you get enough critical mass on the bones, the peaks and troughs are very big," says Byrne while recalling his experience with economic crises throughout Asia. "Once you have a bit more meat on the bones, the peaks and troughs are less."

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